Banco Santander, S.A. Q3 FY2023 Earnings Call

Good morning, everybody, and welcome to Banco Santander's conference call to discuss our financial results for the first 9 months of 2023. Just as a reminder, both the results report and presentation that we will be following today are available to you on our website. Let me just highlight that during the presentation, when we refer to global and network businesses, we are following the definition which was given during our Investor Day last February as the new reporting and full management of the group through global businesses will begin in January '24. I am joined here today by our CEO, Mr. Hector Grisi; and our CFO, Mr. Jose Garcia Cantera. Following their presentations, we will open the floor for any and all questions that you may have in the Q&A session. With this, I will hand over to Mr. Grisi. Hector, the floor is yours.

Thank you, Begona. Good morning, everyone, and thank you for joining us. Let me share with you what we will focus on today. First, I'll talk about our 9 months results in the context of how we are progressing with the strategy we outlined at our Investor Day. Jose will then review our financial performance in greater detail, and then I'll conclude with a few closing remarks. As you can see, we had another strong quarter, demonstrating the strength and resilience of our unique business model even in times of market volatility as well as a solid execution of our strategy. We delivered record profit of €2.9 billion, which is an increase of 20% compared with Q3 in '22, that's 26% in constant euros. Profit for the first 9 months of '23 was €8.1 billion, up 13% in constant euros, driven by strong customer revenue growth. Revenue increased by double digits year-on-year, supported by all global businesses and all our regions. Commercial activity remained solid, with 9 million new customers added in the last 12 months, bringing the total to 166 million. We continue to advance towards a simpler, more integrated model through our One Transformation, which is leading to efficiency improvements and growth in profitability. As a result, our efficiency ratio improved 1.5 percentage points year-on-year to 44%. Our return on tangible equity rose 126 basis points year-on-year to nearly 15%, while our earnings per share improved by 17% year-on-year, supported by profit growth and share buybacks. We further strengthened our balance sheet generating capital in the quarter, even after deducting the share buyback on the way, and liquidity remains at comfortable levels and credit quality is quite strong. All of this led to strong shareholder value creation and attractive remuneration. TNAV plus DPS grew 12% during the last 12 months, and we have increased the cash dividend per share by 39% year-on-year. Moving to the income statement...

Thank you, Hector, and good morning, everyone. I will take you through the main lines of the P&L in more detail. Starting with revenue. There was strong growth driven by customer revenue again this quarter, which made up more than 95% of total revenue and explained almost all the growth in the quarter. This was primarily supported by our retail business as we actively managed the interest rate tailwinds in Europe and Mexico and due to the positive fee performance in Latin America. We delivered double-digit growth across most businesses, particularly our network businesses, which made up 38% of total group revenue. The only exception was auto, which was affected by lower leasing income in the U.S. Revenue at the Corporate Center also improved by more than €500 million year-on-year due to higher liquidity buffer, remuneration and a lower impact from foreign exchange hedging. Most of our revenue growth came from net interest income, which continued its upward trend, increasing 7% in the quarter, driven mostly by Europe and Mexico. We see upside potential for further growth in the coming quarters. Nine months 2023 was 16% higher year-on-year in constant euros on the back of positive sensitivity to rising rates, mainly in Europe and Mexico, and volume growth in Digital Consumer Bank, North America and South America. In terms of profitability, we have improved our net interest margin every quarter since the first quarter of 2021. Gains from credit yields outweighed higher funding costs, thanks to our disciplined deposit remuneration, leading to clear margin expansion. In Europe, we are strictly managing deposit costs, especially in Spain and Portugal, where there is excess liquidity in the system and lower credit demand. The U.K. has a more competitive environment, but betas remain in line with our expectations. In South America, deposit rates are more directly linked to market interest rates, which results in negative sensitivity to rising rates. Therefore, as interest rates are starting to decline, we are seeing improved net interest income trends...

Thank you, Jose. To wrap up, these are the messages I will leave with you. Q3 was another strong quarter with customer and double-digit revenue growth supported by all regions and businesses. We are accelerating One Transformation towards a simpler and more integrated model, which is extracting value from our global and network businesses, driving efficiency gains and profitable growth. We have strengthened our balance sheet and increased our CET1, while credit quality remains strong, in line with our expectations. All of this contributes to double-digit growth in shareholder value creation and increased remuneration, and we remain on track to meet our '23 targets. The execution of our strategy, the progress we are making in our platforms and our local leadership makes us confident we can continue to grow and increase profitability. We see further upside potential for net interest income growth from the portfolio repricing and potential interest rate hikes in Europe and a positive outlook for the margins in South America...

Thank you, Hector. We're ready to start the Q&A session. Can we have the first question, please?

Yes. I want to focus on loan growth. In Spain, it has been particularly weak. It's down 10% year-on-year. The sector is minus 3%. I see that most of the 4% is related to Corporate Investment Banking, which is down over 20%, but SMEs and mortgages are also weak. If you can comment on the gap with the sector? We know demand is weak, but you are below the sector. And then more broadly in other regions, loans in the U.K. are also down 5%, while the sector is up 1%, and Brazil is up by just 3%, whereas the sector is growing 9%. Could you elaborate on whether you are repricing margins over volumes, if you are more prudent on risk taking at this point in the cycle? So loan growth in general and in Spain, in particular.

Francisco, yes, as you have said, loan growth has not been good all year, especially in Spain. As you mentioned, it is also being affected by the prepayments in some of the mortgages. If you see the mortgage portfolio, we have seen prepayments up to €6.5 billion so far this year. You are correct. SMEs and mortgages have also faced lower demand for credit. I believe people are being cautious and trying to see how the economy evolves, even though employment continues to be strong and demand remains robust. This is a fact, and we have observed clients adopting a more cautious approach. Nevertheless, if you look at our portfolio in the rest of the countries, mainly Latin America has continued to grow. There, we have been maintaining a very, very cautious credit appetite, but also focused on profitability. So we're growing the portfolio in Latin America in a solid manner, but in a profitable way. Also, DCB has increased and has shown substantial growth during the year, and we will continue to see that over the next few months. All in all, we are 2% below in loans this year, but we foresee that once clients believe that rates are starting to stabilize and the market offers a clearer view of the future, credit demand will gradually return. Jose, would you like to add anything?

No, just one final comment. Risk-weighted assets are down €2 billion in the quarter, but it's exclusively due to foreign exchange. If we exclude FX impacts on risk-weighted assets, they are actually flat in the quarter, which is what matters most for profitability and capital.

It's Antonio from Bank of America. Two questions from me, please. The first one is on the profitability outlook. And the second one on asset quality in the U.S. Starting with the first one, you've reiterated your guidance for the full year, which, if I'm not mistaken, implies a net profit of around €10.9 billion for this year. Can you confirm that's right? And how do you see profitability in 2024? It would be great if you could talk us through how you see the main units performing into next year, particularly Europe, Brazil and the U.S. My second question is about asset quality in the U.S. There was a significant uptick this quarter, and you've been discussing normalization in the cost of risk. Now we've seen lower used car prices and higher delinquencies, but it seems neither of them were material changes. What is driving this? Can you elaborate on what you're seeing specifically on asset quality? And related to that, I think you've confirmed your 200 basis points cost of risk for this year. What do you expect this number to look like next year?

Yes. Thank you, Antonio. On profitability, as I mentioned during the presentation, I reiterate the 15% RoTE. So that gives you the numbers you're looking for, okay? We are comfortable with that. Regarding '24, as I mentioned earlier, we anticipate strong first-half performance in Europe due to portfolio repricing. We then expect a strong second half in Latin America, as things are improving there. You've already seen how Latin America has performed better when looking at this quarter's numbers. In terms of asset quality in the U.S., I have consistently noted that this is always seasonal. A look at last year, specifically in the third quarter, shows similar dynamics. But the reality is that it's better than we anticipated. We also don't expect it to exceed the 200 basis points, as noted previously. We see that for 90-day delinquencies or higher, repossession rates have shifted from over 90% to about 60% to 65% now. If this trend continues, along with stable used car prices in the U.S., we could see better performance than expected. Importantly, we have a healthier mix in our portfolio now, with prime and near-prime customers making up around 41% of the mix, allowing us to maintain profitable asset quality. Our U.S. market continues to do well due to the strong employment trends we observe.

Yes. Just one final comment on U.S. asset quality. The cost of risk in 2019 was 2.85%. Given the changes in the mix that Hector mentioned, we don't expect to reach those levels at all. We expect the cost of risk in 2024 to remain fairly flat, possibly slightly higher than in 2023 within the U.S. In terms of profitability, we continue to have negative sensitivity to rates in Latin America. Therefore, as rates decline, we will see accelerated momentum in net interest income, particularly in Brazil, coupled with higher loan growth and stable or slightly improving asset quality. Clearly, profitability in South America, as Hector noted, is set to gain momentum in the second half of the year.

And in Europe, as noted, we still have significant repricing left on the asset side. For instance, we have around €80 billion in mortgages in Spain, which normally reprices about 112% every month. In fact, we've managed to reprice 60% of this total in the first half. Thus, our continued repricing of the mortgage portfolio in Spain on a year-on-year basis will be substantial, particularly in the early part of the upcoming year. In summary, the repricing on assets, especially in Spain, along with potential pressures on deposits, will support profitability growth in the first half of the year.

Yes. Here is Sofie from J.P. Morgan. Just to follow up on the previous question. Could you remind us of the current deposit beta in Spain, how it moved in the quarter, and how you expect it to change in other regions, mainly the U.K., U.S., and Portugal? My second question would be regarding the U.S. tax rate, which was very low this quarter. How should we think about the U.S. tax rate going forward? What does a normalized run rate look like? And if I may, please comment on any capital headwinds going forward?

Thank you, Sofie. Could you repeat the second question? We couldn't hear you well. First of all, on deposit betas, I mean, betas today in most geographies remain below our initial expectations. In general, they are behaving rather reasonably, and we expect pressure to mount in the coming months, which will lead to an increase in betas. The geographies we operate in are showing varying behaviors. Our CFO will provide further details on that.

Yes. Sofie, in Spain, the total beta is slightly over 20%, approximately 22%, but we exclude Corporate Investment Banking from this figure. For Corporate Investment Banking, the beta is already almost fully priced. Excluding it, our beta is 13%. Remember that we have €153 billion in current accounts with very low volumes. The beta here is almost 0. We don’t expect any significant change in market behavior in the coming quarters, so we expect gradual increases in beta in Spain, but only incrementally. In the U.K., the beta is 35%. In this quarter, the beta went higher, sitting around 50%. We would thus expect higher betas here as well, but we are also pricing assets higher. The new mortgage pricing in the U.K. is around 5.7%. This will help withstand the slightly higher betas we anticipate next year. For the other countries: Portugal at 9%, Poland at 30%, and in the U.S., it is 32%, with Corporate Investment Banking excluded, standing at 31%—fully in line with expectations.

Sofie, regarding the U.S. tax rate going forward, we believe we may improve it given that we are initiating leasing on electric vehicles, which would benefit us concerning today’s tax rate. However, for a detailed discussion, we can contact you later to provide more clarifications around that. Regarding capital headwinds, the only significant one faced would be due to the final implementation of Basel III. The comprehensive impact is expected to be around 50 to 55 basis points, while the phased implementation charge on January 1, '25 is projected to be between 15 to 20 basis points—essentially aligning with our previous expectations.

I have just 2 questions. The first one on Brazil. After the strong performance we saw this quarter, where there was growth, you previously guided to an acceleration. As you have commented on the quarter results, should we expect better momentum in the second half? Are you changing anything regarding your risk appetite? Can we expect an acceleration of growth, similar to what we have seen in Mexico? What should we expect for 2024 in Brazil? Additionally, could you provide some insights on what has caused cost growth in Spain this quarter and whether we should expect some synergies arising from One Santander in Spain, or is this more restricted to Mexico and the U.S.?

Thank you. In terms of Brazil, Ignacio, a couple of points. First, as you have seen, we altered our mix a bit. The credit risk cost is improving as we shift towards secured loans, so the performance of our credit portfolio is better than we expected. Additionally, the market has also demonstrated a clearer behavior regarding default rates. Our lending appetite has increased cautiously as we observe positive shifts in credit card and customer loan performance. I believe Brazil is set to see considerable growth momentum due to improved macro conditions, and the reduction of rates is definitely helping.

As I mentioned, the sensitivity to rates is gaining momentum. We have already seen rates decline just 100 basis points from 13.75% to 12.75%. We expect a further drop of 100 basis points in Q4, and potentially 200 to 250 basis points next year, which cumulatively could lead rates to nearly 11.75%. Thus, it’s reasonable to expect that the second half of next year will look much better regarding net interest income than the second half of this year.

My first question is on restructuring charges. I understand your profitability target is underlying. Should we expect any material restructuring charges associated with your new reporting structure? The second question is about your outlook on operating expenses in the U.S. You've made recent hires of investment bankers. What are your expectations regarding costs? How much revenue do you expect to generate as a result? Lastly, what is your effective tax rate in Brazil for 2024, and what are your expectations regarding any potential changes on interest on capital?

Thank you. No, we don't anticipate any restructuring charges stemming from the organizational restructuring we performed. In fact, we are actively working towards lowering costs wherever possible. This relates significantly to the One Transformation initiative, which focuses on simplification, meaning we will reduce our diverse product offering significantly and automate many operations. For instance, in Portugal, following a comprehensive transformation, only 10% of our branch operations now involve handling incidents and problems, meaning that 90% of our time is concentrated on client care. Moving on, regarding the increase in operating expenses in the U.S., what we're doing is complementing our existing Corporate Investment Banking capabilities.

The tax rate in Brazil next year, regarding interest on capital, has been proposed but not yet approved. We are unsure of the final form this tax will take, particularly as the Finance Minister believes more analysis is needed around its impact. The focus of this proposal seems to target companies that are not paying taxes, whereas banks already contribute significantly. So until we have more concrete information, it is uncertain.

I have a quick question regarding revenue performance. You recently mentioned that NII has been the primary driver of revenue momentum. However, reflecting on your earlier comments during the Capital Markets Day, I recall a stronger focus on fee income and non-NII revenues. This seems to be underperforming or diverging from initial expectations. Could you provide further insight into this? Do you believe market momentum is waning, or are you falling behind your initial targets? Secondly, can you elaborate on the cost of risk seasonality in the U.S.? Why is there such a significant concentration of provisions in the third quarter? That clarity would be very beneficial.

Thank you, Carlos. It's vital to comprehend the current market dynamics. As noted, we have experienced a 6% year-on-year increase in fees during the first 9 months, primarily due to customer growth and support from global network business, particularly CIB and payments. Currently, the global business sectors contribute around 42% of total fee income and are expected to rise to 50% by '25 as per our plan. It is also important to recognize that we are adjusting our risk appetite, which will lead to a shift in the portfolio mix. With increased volumes and transaction activity expected, we see this bolstering revenue further down the line. Looking into CIB, we are up 15% compared to last year, while PagoNxt is up 12%. Wealth management has been weaker at around 1%, which reflects current market conditions; this region has been impacted due to economic uncertainties. The auto business saw an overall increase of 5% across all key markets, and retail is appreciating similarly due to an influx of 2 million new active customers. As for the U.S., we notice that seasonality plays a typical role in cost of risk, significantly influencing the quarterly cycles. A lot of factors unique to the U.S. market affect these seasonality patterns.

Regarding reporting changes, we will continue to display countries as a secondary segment while offering horizontal businesses as the primary segments. Thus, you'll receive country-level performance organized by these global businesses and the consolidated global performance organized by individual countries. This dual-reporting structure will enable a thorough comparison across both dimensions.

Sorry for my earlier absence. I have a couple of questions. One is a follow-up regarding provisions for the upcoming 2024. If you could provide insight into how you foresee the U.S. evolving in light of flat provisions, and the specific consideration for repossessions shifting from 60% to 65%, how quickly do you expect repossessions to revert to historic levels? With COVID savings and the resumption of student loans, do you anticipate a return or can you suggest it might take more time? I'd like to understand how you're considering these variables in regard to the U.S. Additionally, on the U.K., you've performed comparatively well, but given the competition in the sector, could you elucidate on your expectations for 2024?

Yes, thank you, Alvaro. Regarding the U.S., it’s crucial to understand the differing dynamics of auto loans compared to Europe and Latin America, where individuals tend to prioritize mortgages. In the U.S., if you lack a car, you cannot commute to work, which significantly alters payment behavior. This distinct culture ensures borrowers handle auto loans with care; thus, we shouldn’t be surprised by the strong performance of this portfolio. Should economic conditions soften, that 60% to 62% repossession rate could potentially increase. It's essential to monitor employment trends, which will heavily influence consumer behavior.

In the U.K., we anticipate a robust year ahead. While strong competition on deposits is present, we've been able to navigate this effectively, positively impacting our overall performance. We're committed to advancing the One Transformation initiative here, which will yield significant opportunities for us. NII has grown year-on-year by 9.3%, fueled mainly by the upward trend in interest rates, and we're maintaining a strong focus on managing spreads and profitability. Although we are prioritizing profitability over market share, we remain optimistic about our performance, which has contributed to a positive outlook for the U.K. for next year.

Yes. I have a few questions. First, could you remind us of the sensitivity of Brazilian interest rates? Next, on the topic of structural tax rates in Brazil and the U.S., concerning your new electric vehicles leasing, will this be a permanent change, or just a one-off? With your guidance confirming a 15% to 17% RoTE target and stating 15% for this year, shouldn't we see a natural acceleration in organic capital generation as well? Additionally, regarding the digital euro, what risks and opportunities do you see arising from its implementation? Have you considered potential impacts on your business model?

Thank you, Andrea. On the digital euro, the European Commission published a regulatory proposal in June, setting a framework for the digital euro's launch. They are emphasizing that discussions should not accelerate ahead of the upcoming European elections in June '24. Instead, they are favoring a careful examination by the new commission and new parliament. Thus, we expect a lengthy negotiation process to achieve a collective agreement. As for regulations, the European Central Bank has just completed the investigation phase regarding the digital euro and announced the initiation of a two-year preparation phase aimed at implementing it. This stage will complete the rule book and select potential infrastructure providers. However, we do not expect the digital euro to be issued before 2026. Meanwhile, Banco Santander aligns with the European authorities to design the digital euro and enhance the pan-European integrated payments market. It’s pivotal to generate value beneficial to consumers, companies, and financial institutions. Additionally, we will continue to monitor potential impacts the digital euro may have on our banks in Europe, and further clarity will come from the regulators as the ECB and the European commission finalize the regulatory parameters.

To respond to your question regarding the sensitivity of Brazilian interest rates, we estimate that for a 100 basis point drop, the impact would be around €150 million, all else being equal. The structural tax rate for the group moving forward is typically around 30%. This year, it will likely be lower due to the tax benefits associated with electric vehicles in the U.S. As for organic capital generation, we will see accelerated growth as profitability rises, with no significant regulatory charges except as previously mentioned. Furthermore, we emphasize optimizing our risk-weighted assets; we have already rotated approximately €15 billion to €18 billion in risk-weighted assets and target a similar level of rotation moving forward.

I have a question about credit cards in Brazil. Can you provide an update on ongoing negotiations between the banking sector and the central bank concerning installment limits on credit card lending in the country? If possible, could you outline the contribution of these lending activities to Brazilian net interest income and any estimates for P&L impact linked with the new measures announced? Beyond a negative NII impact, will these measures affect fee income from diminished transaction volumes? Are there potential offsets, such as lower cost of risk or funding that we should consider?

These negotiations are ongoing. The proposed regulations seem to target corporates chiefly rather than financial institutions, resulting in what might be relatively minor effects. The negotiation stage is critical, and it appears the self-regulation 90-day period will conclude by year-end without any agreement. Thus, it’s likely that the central bank will step in to regulate. However, specific implications of the credit card regulation remain unclear; we believe the banks have already begun adapting to the proposal. While there may be impacts on NII, opportunities remain to offset potential losses, particularly through potential increases in commission income and by continuing to draw upon the substantial turnover in the Brazilian market.

A couple of questions from my side, plus a few follow-ups. Regarding the NII, in Portugal, there was a 40% quarter-on-quarter increase this quarter, and I'm curious about what's causing this despite lower customer spread improvements. Also, what should we expect in the upcoming quarters? About the U.K.'s NII, you suggested high single-digit growth. Is this still anticipated, and how do you see it evolving into the next year?

Thank you, Carlos. Portugal's NII, as you noted, has experienced significant growth. This is mainly attributed to the repricing of the portfolio as rates rise. However, we believe this trend will continue through the end of the year as long as rates stabilize across Europe. Initially, we expect stabilization in Portugal after the growth period. Regarding the U.K., I have already explained that profitability remains above market share priority in this region. We anticipate a solid year ahead, with an expected high single-digit growth in NII alongside our management efforts for cost-effectiveness and optimal asset deployment.

I have two questions: One is on the NII in Spain, where the customer spread widened and you've also increased the ALCO portfolio, but the net interest margin was flat. Could you clarify the reasons behind this and also provide an update on the ALCO portfolio? Secondly, we've witnessed a significant decline in NII in Chile, with the business guiding for lower profits this year. What's the outlook for this year, and when do you expect to see NII improve in 2024?

Yes, relating to the NII in Spain, the country has seen benefits from rising rates. We have seen strong growth from clients, evident by our gaining 651,000 net new customers in the past year. Furthermore, wealth management has increased by 84% year-on-year and CIB by 11%. Between factors like asset repricing and customer base expansion, we expect double-digit NII growth for '23. Notably, there are variables in motion; for example, a substantial portion of our portfolio in Spain will reap benefits from asset repricing in the first half of next year, as highlighted earlier. On Chile, our operating results depend on two key sensitivities: rates and inflation. The shifts we have seen—rates falling and inflation calming—contribute to our anticipation that NII will improve as we move into 2024.

Hugo from KBW. I have a couple of questions. Regarding Mexico, net interest income growth has been quite strong. While I won’t ask why it was unexpectedly high, could you provide guidance on what NII growth you foresee for the full year in euros? Finally, regarding Argentina, conditions remain volatile, especially with upcoming elections. Could you enlighten us on what impacts we could expect from these elections, and what guidance you can provide on earnings for this year and next?

Mexico, as indicated, has shown strong growth in net interest income due mainly to a combination of rising rates and the strategic shift we executed toward credit cards and unsecured loans. I've observed a considerably improved portfolio structure, and I am optimistic about our prospects in 2024. However, specific predictions will greatly depend on ongoing U.S. dynamics, particularly concerning rates. As for Argentina, the environment has been challenging with recent instability. I wouldn't hazard a guess regarding future dynamics. Ultimately, the outcomes hinge on how the government navigates complicated economic challenges following the elections.

We've managed our risk in Argentina mainly to ensure we hedge against inflation. We need to be aware of the significant differences between official and non-official exchange rates. Thus, our primary objective has been to mitigate potential impacts should a currency revaluation occur and maintain our investments intact amidst inflation risks.

Three questions, please. First, regarding the Digital Consumer Bank, the return on tangible book stands at 11%, which is still below your 15% target for the plan. Can you cover the outlook for 2024? Secondly, regarding the ALCO portfolio, I've noted an increase of about €10 billion this quarter. Can you clarify the strategy behind this and the level of unrealized loss in the portfolio? Lastly, for Poland, can you comment on your expectations regarding mortgage volume extensions?

Let me start with Poland. The proposal currently revolves around the existing government but will need to be reviewed by the new government in parliament, rendering any discussion premature. On the ALCO portfolio, we sit at around €27 billion to €30 billion in Spain, averaging yields of approximately 3.4%. We expect to finish the year at around €30 billion, possibly increasing the ALCO further due to higher yields next year. The profitability from this portfolio could vary depending on how we evaluate it against deposit costs or marginal funding. Nonetheless, it will significantly enhance group profitability next year.

For the Digital Consumer Bank, we witnessed a shift within the business space this year. While there's been great growth in loan-related activity, a large portion of these loans comprise stock financing. This stemmed from previous production shortages in the auto market, now resulting in significant volumes with dealerships. We expect as inventory moves, it will lead to a normalization of auto loans and subsequently uplift our net interest income. We are actively managing our deposits to avoid excessive reliance on wholesale funding. While we anticipate growth, it’s essential to consider ongoing market dynamics, particularly in Europe, which can impact the pace at which inventories are moved.

I believe we have no further questions. Thank you very much, everybody, for your time. As always, the Investor Relations team remains at your disposal for any and all questions you may have. Thank you. Bye, bye.